Building a sustainable biotech business with a hybrid model

By QMR Technology

Introduction

Biotechnology companies are currently under great financial pressure. The high-risk profile associated with biotech investments and the long time it takes to get return on investment makes it difficult to gather capital on the financial markets. Over the last couple of weeks we have seen various examples of cancelled IPOs, companies suspending operations due to lack of capital, and companies narrowing their research in order to decrease their cash burn. More than ever there is a need for alternative and innovative business models and strategies as investors are seeking early return on investment and are not willing to run a great deal of risk over longer periods of time. The traditional business models like product and platform models run the risk of falling short of satisfying these requirements as illustrated in the following paragraphs.

The product model – high potential, high risk, long-term value creation

The product model seeks to create value by advancing products through the drug development pipeline and either commercializing these or licensing these to strategic partners at a late stage. As it usually takes more than 10 years to advance a compound through the different stages of clinical development, and as there exists a disproportional high risk that the drug will never make it to the market, it should be clear that this is a challenging scenario considering the current economic circumstances. Having multiple drugs in the pipeline would increase the chance of success, but would also require substantial additional investments. Considering the fact that full development of a drug might cost as much as 800 million dollar (according to a study of the Tufts Center for Drug Development), gathering the required capital from a private or public placement provides a challenge for each biotech company.

The platform model – low potential, low risk, short-term value creation

The platform model on the other hand aims at creating value by creating a technological platform to aid the drug development process where revenues are generated using licensing, subscription and service fees. The platform model is limited in terms of value creation however as it is constrained by the revenues resulting from services provision to customers. A benefit, on the other hand, is the potential of this model to bring in revenues at an early stage, creating value at a relatively short time horizon.

The hybrid business model – combining the strengths of platform and product models

The hybrid business offers a good alternative as it combines the platform and product models, seeking to generate revenues on a short term through service provisioning whilst aiming to generate revenues on the longer term by building an own discovery program for specific diseases and forming strategic alliances with established pharmaceutical companies to generate revenues on the long term through milestone payments.

The Galapagos example

One of the companies that has deployed a hybrid business model and has been highly successful with it is Galapagos. Galapagos is a drug discovery company with pre-clinical programs in bone and joint diseases and bone metastasis. The company was founded in 1999 as a joint venture between Crucell and Tibotec. From the start, Galapagos has operated a hybrid business model, combining internal discovery programs with service activities. Its BioFocus DPI division offers a full suite of target-to-drug discovery products and services to pharmaceutical and biotech companies, encompassing target discovery and validation, screening and drug discovery through to delivery of pre-clinical candidates. BioFocus DPI also provides adenoviral reagents for rapid identification and validation of novel drug targets, compound libraries for drug screening as well as chemogenomics and ADMET database products to select targets and compounds. Galapagos currently employs about 500 people and operates facilities in six countries, with global headquarters in Mechelen, Belgium.

Galapagos gathered capital through a private placement in 2002, the IPO in 2005 and went through subsequent private placement financing rounds in 2006 and 2007. This allowed the company to successfully pursue its acquisition strategy that in turn enabled its service division to offer a full suite of target-to-candidate drug discovery products and services. The products and services include target discovery and validation, screening and drug discovery through to delivery of pre-clinical candidates. Galapagos has entered into long-term alliances for the majority of its research programs with top ten pharmaceutical companies.

To find out what made Galapagos successful in operating the hybrid business model I spoke with André Hoekema, SVP Corporate Development and Elizabeth Goodwin, Investor Relations Manager of Galapagos.

Galapagos has two divisions; the BioFocus DPI service division and the Galapagos drug discovery division. What is the most notable difference in the way that the two divisions operate?
AH: “Most notable is that the two divisions have a completely different focus. The contract manufacturing division has a strong focus on short-term revenue generation and therefore sales and marketing is at the heart of this entity. The focus of the drug discovery unit on the other hand is based on innovation and has a strong R&D focus.”

Galapagos provides services in the field of contract manufacturing and also has its own clinical development program for the same diseases, which might seem like a conflict of interest. How do you deal with the expertise gathered within the contracts division and how do you handle the intellectual properties?
AH: “The two are actually treated as different activities and are completely separated from an organizational point of view. Our services and clinical development programs have a ‘Chinese wall’ between them and are in all aspects treated as separate entities to prevent any contamination. Each of the two divisions has its own structure and management and each of the two divisions is reported on separately in our financial reports. Of course there is the benefit of interchanging expertise and knowledge between the two divisions, and in fact Galapagos R&D is a customer of BioFocus DPI.”

Do you have any specific recommendations for a biotechnology company that wants to deploy the hybrid business model?
AH: “In general there are a number of critical success factors that contribute to the hybrid business model.

• The direct benefit of each unit is defined clearly, as well as the synergies between units, and these are closely monitored.
• Dedicated management for each part of the model.
• Clarity has to be provided to the outside world on the elements in the hybrid model, like differentiation of goals, reporting etc.”

How have these recommendations been implemented in the Galapagos organization structure?
AH:

• The Galapagos business unit drives development of candidate drugs where the BioFocus DPI business unit drives services revenues. The synergies exist in outsourcing of the Galapagos programs to BioFocus DPI, and in the contribution of BioFocus DPI to generate cash to the company.
• Galapagos and BioFocus DPI have separate management teams, with different goals ('to the clinic' versus 'profitability').
• Galapagos and BioFocus DPI are reported separately and transparently.”

In your experience, does the hybrid model provide more confidence to shareholders?
EG: “ Our shareholder base is roughly 90% institutional and 10% private investors. Both categories of investors value the benefits of a hybrid model. The services business is seen by many in the markets as one that generates revenues and cash, forming the core of their valuation models. The newsflow on the services side also gives them confidence that the division is growing its external business as well or better than peers. The R&D side then presents a cheap option for significant upside on top of the service division, with the synergies of our hybrid model further strengthening this view. Now that we are also delivering considerable revenues from R&D as a result of our alliance strategy, some are beginning to place more value on the pipeline. Galapagos' unique twist on a hybrid model is gaining more attention as a viable and sustainable way forward without going to the markets for cash. We were particularly proud to welcome Dutch insurance company Delta Lloyd as a major shareholder with 5.4% of Galapagos in September this year ”

A lot of biopharmaceutical companies struggle to seek additional capital for drug development or clinical research. In fact we have also seen examples the last couple of days of companies that have successfully advanced drugs through clinical trials but are now unable to raise additional capital to support the marketing of their products. Could the hybrid business model cope with difficult conditions in the capital markets?"
AH: “In today's market, the availability of capital to biotech companies is worse than ever. In this climate, biotech companies need to find ways to keep their financial burn at a minimum. A hybrid business model with a cash-generating segment can provide that, and may prove to be especially beneficial under the current conditions.

Conclusion

As already stated in the introduction a lot of biotechnology companies are restructuring to preserve cash, reassessing their business strategy, and considering alternatives. If we look at the way Galapagos has increased its revenues and see how this enabled the company to establish an impressive pipeline with equally impressive strategic alliances, it clearly illustrates the direct benefits of the hybrid business model. A services strategy will enable a company to obtain revenues prior to achieving income from its own products. What can be learned from the Galapagos example is that a clearly defined strategy and a portfolio of marketable services with a focus on specific diseases can offer competitive advantage to its customers. An additional benefit is that the service provisioning will bring the company on the radar screen of potential strategic partners to incorporate risk sharing in their own drug development programs.

Investors are seeking solid investments with a low risk profile and a reasonable timeframe in terms of value creation and return on investment. In my opinion the best possible strategy at this time would be for biotech and big pharma to form early stage alliances providing a great deal of synergy. Biotechnology companies are flexible, innovative, and have a strong appetite for risk towards finding cures for unmet medical needs. Big pharma, on the other hand, has a high level of drug development expertise, big cash reserves, and a very high level of competence in regards to sales and marketing. Partnerships between biotechnology and pharma will provide a great deal of synergy and will enable both to benefit from each other’s strengths and possibilities.

Biographies

Andre Hoekema, PhD, SVP Corporate Development
Dr. Hoekema joined Galapagos in March 2005 from Invitrogen Corporation, where he was Managing Director of Corporate Development Europe. He brings 20 years of biotech experience from positions at Molecular Probes Europe (Managing Director), Crucell (Director of Business Development), DSM Life Sciences and MOGEN (Research and Project Management) and Genentech, Inc (R&D). Dr. Hoekema has a PhD degree from Leiden University and is the inventor of over 20 series of patent applications, resulting in 15 patents issued in the US.

Elizabeth Goodwin, Manager Investor Relations
Elizabeth Goodwin is Manager Investor Relations at Galapagos NV since 2005. Prior to that she was Director Investor Relations & Corporate Communications at Crucell NV, ran her own marketing and PR firm, held marketing positions at Telfort (British Telecom) and Ericsson in Europe, and worked in finance positions at General Electric in the US. Elizabeth holds a Bachelor of Arts degree in Economics and Spanish from Washington University in St. Louis, and an International MBA degree from Nyenrode University in the Netherlands.

Willem van Leeuwen, Managing Director QMR Technology
Willem van Leeuwen is managing director of QMR Technology, a Dutch consulting company delivering world-renowned Oracle business solutions for small and medium enterprises pertaining to the life sciences industry. His experience portfolio includes numerous implementations of the ERP system Oracle E-Business Suite and the Oracle Life Sciences Applications for Clinical Data Management, Adverse Event Reporting and Clinical Trial Management.